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FDIC Prevails in Suit Blaming IndyMac Execs for Construction Losses

DEC 11, 2012 9:57am ET
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IndyMac became infamous for lending to homeowners with such abandon that it ended up in a multibillion-dollar bankruptcy. On Friday, a jury agreed with the Federal Deposit Insurance Corp.'s contention that its residential construction division also acted recklessly.

The verdict, in U.S. District Court for the Central District of California, declared three former IndyMac execs culpable for more than $168 million in loan losses. The decision may prove pivotal to the FDIC in recouping a small portion of the more than $12 billion of losses it suffered in the wake of the lender's bankruptcy. The men's liability for the bank's mistakes allows the FDIC to pursue insurance claims involving policies protecting them against findings of negligence.

The case was litigated on behalf of the FDIC by Nossaman LLP, a Los Angeles-based law firm. It is the first suit to go to trial among 39 that the regulator has brought against the directors of failed banks.

Attorneys for the FDIC claimed during trial that the worst of the IndyMac homebuilding division's excesses began in 2004. That, they argued, was when the three defendants—division chief executive Scott Van Dellen, chief lending officer Richard Koon and chief credit officer Kenneth Shellem—concluded that lender competition for blue-chip residential construction loans was driving down margins. The three executives responded by shifting their division's focus to targeting "smaller, less price competitive builders," the FDIC argued.

Meanwhile, the executives failed to put in place the controls required to manage this business, the regulator added. Instead the FDIC claimed that the homebuilder lending unit: gave underwriters control over credit risk decisions; ignored borrowers' lack of construction experience and high debt loads; failed to demand adequate collateral; and paid underwriters premiums for arranging high-yield loans.

Attorneys for the defendants, by contrast, argued during the trial that top IndyMac executives, rather than the three former executives on trial, were at fault for setting overly aggressive targets. They also pinned blame for the division's troubles on the unprecedented size of the housing bust.

Attorneys for Koon and Shellem added during trial that the Office of the Comptroller of the Currency had repeatedly signed off on the division's operations.

In response to the jury's verdict, defense attorney Kirby Behre of Paul Hastings, who represents Koon and Shellem, issued a statement decrying the FDIC's decision to pursue the men in the first place.

"Today's verdict is the result of a deliberate effort by the government to scapegoat a few men for the impact that the unforeseen and unprecedented housing collapse in 2007 had at IndyMac and at many, many other financial institutions," the statement said. "Mr. Shellem and Mr. Koon used the utmost care in making loan decisions, and there is no doubt that all of the loans at issue would have been repaid except for the housing crash. By unfairly using hindsight to call into question these lending decisions, the government sought to pin the blame on these men for results not of their making. Unfortunately, in the current climate, it is difficult for anyone involved in the banking industry to be treated fairly."

Van Dellen was defended by an attorney from another firm, who did not immediately respond to a request for comment.

The trial that concluded Friday could have implications for a separate FDIC suit pending in the Central District of California that accuses former IndyMac chief executive Michael Perry of negligence. Documents cited in the homebuilder lending case suggest that Perry warned Van Dellen to exercise caution as the bubble crested.

"Be careful, especially on our new construction projects," Perry wrote in comments that he forwarded to the division head, along with a series of 2006 news articles warning of an industry slowdown. In another document filed with the court, Perry wrote that, unlike residential mortgage lending, construction loans required extensive credit risk controls.

Lower level IndyMac employees likewise expressed concern about potential excesses. One loan officer called the division's growth plans "insane," given the way the market had stalled by late 2006.

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